Retirement systems all around the world are going through the process of transition, as these systems strive to adjust to the challenges of decreasing ratios of workers to retirees. Governing bodies attempt to support responsible behavior via implementing regulations that encourage savings and investments.
In the U.S., the Pension Protection Act of 2006 (PPA) has been one of the most notable steps in this direction. In the defined benefit (DB) plans area, PPA modified and simplified a number of regulations including the rules for calculating minimum required and maximum tax-deductible contributions. The classic actuarial approach of calculating present values using the expected portfolio return is no longer required. The regulations contain no suggestions regarding the optimal level of contributions that would represent a sensible compromise between several competing objectives (lower cost, higher safety of benefits, stability and predictability of contributions). A comprehensive risk management framework that includes asset allocation, contribution and benefit design policies and attempts to maximize the safety of the promised benefits and minimize the cost of providing these benefits has not been developed.
With respect to the defined contribution (DC) plans, PPA encourages reasonable auto-enrolment policies and provides safe harbor protection to several investment vehicles (Qualified Default Investment Alternatives, or QDIAs). Target date funds and similar funds—the ones that adjust their portfolios as the target date approaches—are representatives of these QDIAs. As a result, the popularity and utilization of target date funds has significantly increased and should increase even more in the future.
Yet, target date funds have significant problems. By design, age and time until retirement are the only decision factors in the selection of these funds. As a result, a 50-year-old CEO and a 50-year-old janitor that plan to retire in 15 years have the same asset allocation despite the enormous differences in risk tolerance, current balances, and future earnings these individuals may have. The need to customize target date funds to specific groups is greater than ever.
Moreover, the economic theory for the design of target date funds is still in its infancy. The central feature of a target date fund is its “glide path”—a series of portfolios that evolve from more aggressive for younger investors to more conservative for older ones. While there are a number of providers of target date funds, a common principles based unified approach appears to be nonexistent at this point. Ibbotson Associates, one of the largest independent providers of investment advisory services, has stated the following recently:                “Although competing firms race to release target maturity solutions, most target maturity equity glide paths lack theoretical substance . . . . Little rigorous work has been done to answer how and why the equity-bond glide path should evolve throughout an investor's lifetime, and even less work has been done to answer how and why intra-stock and intra-bond splits should evolve over time.”Source: Lifetime Asset Allocations: Methodologies for Target Maturity Funds, Ibbotson Associates Research Report, February, 2008, Ibbotson Associates, Inc.        
The existing approaches cannot justify even the most basic folk wisdom that people should be more risk tolerant when young and less so when older, reducing their exposure to risky assets. The theoretical models currently used in the industry, while complicated, nevertheless appear to be based on overly simplistic assumptions that do not take fully into account some of the most important factors that significantly affect the solutions.
The optimization and simulation models utilized by various providers of asset allocation services are usually expensive, inflexible, and intuitively unclear. Moreover, in most cases, the underlying theory behind the glide path construction in these systems, if exists, is not disclosed. While the people who manage retirement programs have a fiduciary responsibility to understand how retirement assets are and will be invested, the information available to them does not appear to be sufficient to discharge this responsibility prudently.
Overall, there is a significant gap between the needs of the practitioners in the industry and the risk management tools available to them. It would be desirable to maximize post-employment income, minimize risk to this income, and minimize saving rates needed to achieve this income. It would be further desirable to provide methods for efficient portfolio selection, for designing contribution policies, and selecting feasible financial commitment. To date, the foregoing needs have been unmet.